The Market Plays Along as the Fed Gets It Wrong

The Fed has told the market that the economy is as bad as we all thought -- but the market rallies?

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I can understand the Fed action since they only have so many tools at their disposal and they felt a need to take action to help on the job front. But the Fed should have kept this action in its back pocket in case things get worse. Let's remember that US corporate earnings are at a record level. Companies are not having trouble making money. That is still a major measurement of the health of our economy. The problem with jobs is a huge concern – but it is better handled by policy from Washington legislators, not the Fed. After all, what does it say that US corporate earnings are at an all time high while unemployment persists?

OK, so you know I think the Fed was wrong. And we know the Fed thinks things are bad, so they took this action. But the market rally really continues to disturb me. The Fed has told the market that the economy is as bad as we all thought – but the market rallies?

I know why it rallies! The two big reasons: (1) The Fed is buying risk assets (mortgages), which means that all risk assets get a boost. After all, the sellers of the MBSs to the Fed will need to re-deploy their assets. They will likely be looking for something with a return higher than the artificially depressed mortgage returns. (2) The Federal government has announced that it will throw money at the problems if they get bad enough. In the short term, lots of companies that produce goods and services stand to benefit from the influx of funds from the government.

But the long-term investor needs to be worried. The market cannot justify these valuations if the economy is truly getting worse. The Fed actions to print money also are a worry for inflation. So, while the market will likely extend its rally here, the long-term outlook is more worrisome.

The market has rallied slowly for two to three weeks in to this announcement. In other words, it saw the Fed action coming. The Fed even signaled it. So, I think the majority of the rally is baked in. We are approaching the highest levels that I think the S&P can justify on this Fed move – a level around $1475. Remember that the price of the S&P 500 (^GSPC) is just one of those vital signs the doctor looks at. Eventually, the adrenaline wears off – and then you still need to treat the patient!

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